As John blogged last week on DealLawyers, SPACs have been having a “moment” due to this year’s market volatility. Yesterday afternoon, Corp Fin issued a new “Securities Act Forms” CDI #115.18 to address the Form S-3 eligibility of companies that go public via merger into a SPAC.
Question 115.18
Question: Following the merger of a private operating company or companies with or into a reporting shell company (for example, a special purpose acquisition company), may the resulting combined entity rely on the reporting shell company’s pre-combination reporting history to satisfy the eligibility requirements of Form S-3 during the 12 calendar months following the business combination?
Answer: If the registrant is a new entity following the business combination transaction with a shell company, the registrant would need 12 calendar months of Exchange Act reporting history following the business combination transaction in order to satisfy General Instruction I.A.3 before Form S-3 would become available. If the registrant is a “successor registrant,” General Instruction I.A.6(a) would not be available because the succession was not primarily for the purpose of changing the state of incorporation of the predecessor or forming a holding company. General Instruction I.A.6(b) also would not be available because the private operating company or companies would not have met the registrant requirements to use Form S-3 prior to the succession.
Where the registrant is not a new entity or a “successor registrant,” the combined entity would have less than 12 calendar months of post-combination Exchange Act reporting history. Form S-3 is premised on the widespread dissemination to the marketplace of an issuer’s Exchange Act reports over at least a 12-month period. Accordingly, in situations where the combined entity lacks a 12-month history of Exchange Act reporting, the staff is unlikely to be able to accelerate effectiveness under Section 8(a) of the Securities Act, which requires the staff, among other things, to give “due regard to the adequacy of the information respecting the issuer theretofore available to the public,…and to the public interest and the protection of investors.” [September 21, 2020]
219.05 In reporting compensation for periods affected by COVID-19, questions may arise whether benefits provided to executive officers because of the COVID-19 pandemic constitute perquisites or personal benefits for purposes of the disclosure required by Item 402(c)(2)(ix)(A) and determining which executive officers are “named executive officers” under Item 402(a)(3)(iii) and (iv). The two-step analysis articulated by the Commission in Release 33-8732A continues to apply when determining whether an item provided because of the COVID-19 pandemic constitutes a perquisite or personal benefit.
– An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties.
– Otherwise, an item that confers a direct or indirect benefit and that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, is a perquisite or personal benefit unless it is generally available on a non-discriminatory basis to all employees.
Whether an item is “integrally and directly related to the performance of the executive’s duties” depends on the particular facts. In some cases, an item considered a perquisite or personal benefit when provided in the past may not be considered as such when provided as a result of COVID-19. For example, enhanced technology needed to make the NEO’s home his or her primary workplace upon imposition of local stay-at-home orders would generally not be a perquisite or personal benefit because of the integral and direct relationship to the performance of the executive’s duties. On the other hand, items such as new health-related or personal transportation benefits provided to address new risks arising because of COVID-19, if they are not integrally and directly related to the performance of the executive’s duties, may be perquisites or personal benefits even if the company would not have provided the benefit but for the COVID-19 pandemic, unless they are generally available to all employees.
Today: “Proxy Disclosure Conference – Part 2”
Today is the second day of our “Proxy Disclosure Conference” – tomorrow is our “17th Annual Executive Compensation Conference.” You can still register online to get immediate access to these virtual events! Both conferences are paired together and they’ll also be archived for attendees until next August. That’s a huge value.
– How to Attend: Once you register, you’ll receive a Registration Confirmation email from mvp@markeys.com. Use that email to complete your signup for the conference platform, then follow the agenda tab to enter sessions. All sessions are shown in Eastern Time – so you will need to adjust accordingly if you’re in a different time zone. Here’s today’s agenda. If you have any questions about accessing the conference, please contact Victoria Newton at VNewton@CCRcorp.com.
– How to Watch Archives: Members of TheCorporateCounsel.net or CompensationStandards.com who register for the Conferences will be able to access the conference archives until July 31, 2021 by using their existing login credentials. Or if you’ve registered for the Conferences but aren’t a member, we will send login information to access the conference footage on TheCorporateCounsel.net or CompensationStandards.com.
– How to Earn CLE Online: Please read these “CLE FAQs” carefully to confirm that your jurisdiction allows CLE credit for online programs. You will need to respond to periodic prompts every 15-20 minutes during the conference to attest that you are present. After the conference, you will receive an email with a link. Please complete the link with your state license information. Our CLE provider will process CLE credits to your state bar and also send a CLE certificate to your attention within 30 days of the conference.
Today and tomorrow is our “Proxy Disclosure Conference” – Wednesday is our “17th Annual Executive Compensation Conference.” Here are the agendas: 15 substantive panels over 3 days – plus 6 breakout roundtables today that you can choose from. Check out my promo video to see what’s in store! You can still register online to get immediate access to these virtual events! Both conferences are paired together and they’ll also be archived for attendees until next August. That’s a huge value.
– How to Attend: Once you register, you’ll receive a Registration Confirmation email from mvp@markeys.com. Use that email to complete your signup for the conference platform, then follow the agenda tab to enter sessions. All sessions are shown in Eastern Time – so you will need to adjust accordingly if you’re in a different time zone. Here’s today’s agenda. If you have any questions about accessing the conference, please contact Victoria Newton at VNewton@CCRcorp.com.
– How to Participate in a Roundtable: New this year, we have added interactive roundtables to discuss pressing topics! We hope you’ll join us for one of these half-hour breakout sessions. Space is limited for those, but you can save yourself a seat ahead of time by navigating to the agenda tab in the mvp platform and clicking on the seat icon next to the roundtable you want to attend.
– How to Watch Archives: Members of TheCorporateCounsel.net or CompensationStandards.com who register for the Conferences will be able to access the conference archives until July 31, 2021 by using their existing login credentials. Or if you’ve registered for the Conferences but aren’t a member, we will send login information to access the conference footage on TheCorporateCounsel.net or CompensationStandards.com.
– How to Earn CLE Online: Please read these “CLE FAQs” carefully to confirm that your jurisdiction allows CLE credit for online programs. You will need to respond to periodic prompts every 15-20 minutes during the conference to attest that you are present. After the conference, you will receive an email with a link. Please complete the link with your state license information. Our CLE provider will process CLE credits to your state bar and also send a CLE certificate to your attention within 30 days of the conference.
EU Considering Options for “Sustainable Corporate Governance”
The European Commission is studying the root causes of “short-termism” and wants to enact an EU-level solution that would make directors more accountable for companies meeting the UN Sustainable Development Goals and the goals of the Paris Agreement on climate change. The findings are summarized in this 185-page report – and it looks like one option that’s on the table is changing the formulation of director duties in EU nations. It characterizes these 7 areas as “key problem drivers” (also see this Wachtell memo):
1.Directors’ duties and company’s interest are interpreted narrowly and tend to favour the short-term maximisation of shareholder value
2.Growing pressures from investors with a short-term horizon contribute to increasing the boards’ focus on short-term financial returns to shareholders at the expense of long-term value creation
3.Companieslack a strategic perspective over sustainability and current practices fail to effectively identify and manage relevant sustainability risks and impacts
4.Board remuneration structures incentivize the focus on short-term shareholder value rather than long-term value creation for the company
5.The current board composition does not fully support a shift towards sustainability
6.Current corporate governance frameworks and practices do not sufficiently voice the long-term interests of stakeholders
7.Enforcement of the directors’ duty to act in the long-term interest of company is limited
B-Corps: Getting More Useful?
Last week, Veeva Systems – an NYSE-traded company with a $40B market cap – announced that it had formed a board committee to explore becoming a public benefit corporation – along with shedding its main anti-takeover provisions. That’s a pretty unique move for a company that’s not even consumer-facing, and if Veeva proceeds, they would join only three publicly traded companies incorporated under Delaware’s “public benefit corporation” statute – Laureate Education, Lemonade and Vital Farms.
Some are predicting that more might convert – or that we will see more public company subs going that route, as Danone North America and Proctor & Gamble’s “New Chapter” have done. This MoFo memo analyzes the three current public company PBCs, extracts some lessons, and explains the possible benefit:
An obligation to report on ESG considerations and risks is not the same as an obligation to pursue a public benefit potentially to the detriment of short-term stockholder value. Adopting a PBC form allows boards of directors and management to balance these considerations and make the choices they think are right, while having a defense from activist stockholders that may be off-put by a quarter or year of lower-than-hoped results. Because of this, PBCs have been touted as a potential solution both to the problem of short-termism in issuer and investor behaviors and to companies seeking to maximize profits for stockholders and passing associated negative externalities to the public at large.
Meanwhile, this Seyfarth memo notes some of the hurdles for public company PBCs – compared to the over 3,000 privately held companies have now gone through the B-Lab process to become Certified B-Corps. Here’s an excerpt:
Because of the need for, and cost associated with, a shareholder vote to reincorporate an entity, among other reasons, this can be a practical barrier to B Corp certification for public companies. Notwithstanding, B Corps are slowly making their way into the public company space – with Danone North America leading as the world’s largest B Corp. At this juncture, the few other public B Corps were certified before becoming public.
Demand for B-corps – although limited – may be helped along by Delaware’s recent amendments to its “public benefit corporation” statute – which make it easier to convert to that structure and afford more protections to PBC directors. As John recently blogged on The Mentor Blog, this Ropes & Gray memo takes a deep dive into the amendments. Here’s a summary:
– Voting Thresholds for Opting In and Opting Out Lowered. The 2020 PBC amendments eliminated Section 363(a) and (c) – which had originally required 90% approval to convert in or out of PBC status. The result is that the voting thresholds for conversions, mergers and consolidations involving PBCs are now governed by Sections 242(b) and 251 of the DGCL, which provide for majority voting unless the certificate of incorporation provides otherwise.
– Elimination of Statutory Appraisal Rights in Connection with PBC Conversions. The 2020 PBC amendments eliminated Section 363(b) – which had provided appraisal rights to stockholders who didn’t approve of a conversion to the PBC entity form. As a result, there no longer is a specific statutory appraisal right if a conventional corporation converts to a PBC. Appraisal rights in connection with PBC mergers and consolidations are now governed by Section 262 of the DGCL, which addresses appraisal rights in connection with mergers and consolidations more generally.
– Director Protections Strengthened. As discussed above, under Section 365(a) of the DGCL, directors of a PBC must balance the pecuniary interest of stockholders, the interests of other stakeholders and the specific public benefit identified in the certificate of incorporation. Section 365(c) has been amended to clarify that a director’s ownership of stock or other interests in the PBC does not inherently create a conflict of interest, unless the ownership of the interests would create a conflict of interest in a conventional corporation.
In addition, the 2020 PBC amendments revised Section 365(c) to provide that any failure on a director’s part to satisfy Section 365(a)’s balancing requirement does not constitute an act or omission not in good faith or a breach of the duty of loyalty for purposes of Section 102(b)(7) (exculpation of directors) or Section 145 (indemnification) of the DGCL, unless the certificate of incorporation provides otherwise. Previously, this was framed as an opt-in in Section 365(c), rather than as an opt-out.
– Ability to Bring Derivative Suit Brought into Alignment with Conventional Corporations. Amendments to Section 367 align the thresholds for PBC derivative actions with those applicable to conventional corporations.
Farewell to Justice Ruth Bader Ginsburg
Late Friday, the SEC Commissioners issued a joint statement on the passing of Justice Ruth Bader Ginsburg (here is her NYT obituary):
We join the nation in mourning the passing of Justice Ruth Bader Ginsburg. Justice Ginsburg’s powerful intellect and determination shaped decisions that had meaningful impacts for all Americans, including our nation’s investors. She inspired many, and her trailblazing career will serve as a model of public service and dedication to our country for generations to come.
Lynn blogged last week about the SEC’s amended “accredited investor” definition. We’re posting the avalanche of memos in our “Private Placements” Practice Area. Courtesy of the Stinson firm, we’ve also now posted a sample subscription agreement – in Word format and in a redlined PDF that shows updates for the new definition.
Eight Steps to Better Board Succession
This Heidrick & Struggles memo describes the increasingly complicated and important issue of board composition – and notes that too few boards rigorously evaluate their composition to ensure they’re meeting demands for digital & sustainability expertise and diverse experiences. If director recruitment is an ongoing process, boards are better able to plan ahead and “future-proof” the organization. They recommend these eight steps to better board succession:
1. At least annually, evaluate board composition, individual director performance, and full board effectiveness in the context of the organization’s strategic objectives and purpose.
2. Make sure a single person is accountable for that process (likely the chair of the nominating and governance committee) but that it is broadly embraced by the full board.
3. Establish benchmarks for key areas of board composition, considering peer boards or other high-performing organizations.
4. Map out the skills and experiences the board will need to meet its objectives for the next 5 to 10 years holistically, taking into consideration multiple directors moving on and off the board. Refresh and discuss these needs annually.
5. As the company’s needs change, so should the board. Board refreshment through term limits, age limits, and regular evaluations against the strategic skills matrix is key.
6. Develop new recruitment strategies that challenge long-held norms about the most useful networks for recruiting and the most important types of career experience. Search broadly. Be open minded. (Note – this is especially important given investors’ focus on diversity)
7. Build relationships now with potential future directors. Get to know them today for tomorrow’s needs.
8. Ensure the board is both inclusive and attractive to potential directors. Test your assumptions about what inclusivity means for your board.
Transcript: “CEO Succession Planning in the Crisis Era”
We’ve posted the transcript for our recent webcast: “CEO Succession Planning in the Crisis Era,” which covered these topics:
– Why succession planning should be high priority
– How to maintain a dynamic & adaptable succession plan
– Keeping track of contract & procedural requirements
– Disclosure implications
– Transition mechanics
– Steps for boards & advisors to take right now
Earlier this week, the SEC announced two pretty substantial whistleblower awards – a joint $2.5 million award and a $1.25 million award – which looked like a lead-up to yesterday’s highly anticipated open meeting, at which the Commission would consider adopting amendments to its whistleblower program. Late Tuesday, however, the SEC posted a cancellation notice for the open meeting, and while sometimes the Commission still moves forward with rule adoption in that scenario, it’s not the case this time around (at least so far).
While the rulemaking delay might be a function of holiday schedules, given the controversial nature of the proposed amendments, this WSJ article notes that it’s the second time rulemaking has been called off and speculates that the Commissioners may not have reached consensus quite yet. The article summarizes the history behind the proposed changes – here’s an excerpt:
The regulator unveiled the proposed changes in 2018. Under the whistleblower program, tipsters who provide information that leads to a successful enforcement action against a company can be eligible for an award of between 10% and 30% of the overall monetary sanction.
Whistleblower advocates have supported changes that the SEC says would make it more efficient in processing claims, including one that would allow it to ban tipsters who provide false information or make repeated, frivolous claims.
But they have mounted a vocal opposition to several other amendments, including one that would allow the SEC to downsize awards for information that leads to fines of $100 million or more, simply because of their size. The amendment would disincentivize the highest-paid Wall Street insiders from providing information, whistleblower lawyers have said.
Whistleblower advocates have also criticized new guidance that could restrict the type of information whistleblowers can be rewarded for providing, and a new rule that disqualifies tipsters who don’t submit a special form before contacting the SEC.
DOL Takes Another Crack at ESG
Earlier this week, the US Department of Labor issued this proposal – to clarify how ERISA fiduciaries should exercise their proxy voting and other shareholder rights under the statute’s “investment duties” section. In a defensive move against “ESG” voting, the proposal says that fiduciaries can’t vote any proxy unless they determine that the matter has an economic impact on the plan. And as a follow-up to the SEC’s proxy advisor rules, the proposal also outlines “permitted practices” that fiduciaries are able to follow when voting, such as applying proxy voting policies. This Stinson blog gives more background – here’s an excerpt:
The DOL is concerned that some fiduciaries and proxy advisory firms may be acting in ways that unwittingly allow plan assets to be used to support or pursue proxy proposals for environmental, social, or public policy agendas that have no connection to increasing the value of investments used for the payment of benefits or plan administrative expenses, and in fact may have unnecessarily increased plan expenses
The Department has issued sub-regulatory guidance and individual letters over the years affirming that, in voting proxies and in exercising other shareholder rights, plan fiduciaries must consider factors that may affect the value of the plan’s investment and not subordinate the interest of participants and beneficiaries in their retirement income to unrelated objectives. The Department believes, however, that aspects of the guidance and letters may have led to some confusion or misunderstandings. The proposal is designed to address those issues through a notice and comment rulemaking process that will build a public record to help the Department develop an improved investment duties regulation with the goal of ensuring plan fiduciaries execute their ERISA duties in an appropriate and cost-efficient manner when exercising shareholder rights.
According to a DOL official, the proposal would clarify Employee Retirement Income Security Act fiduciary duties for proxy voting and monitoring proxy advisory firms. In addition, the proposed rule would reduce plan expenses by giving fiduciaries clear directions to refrain from spending workers’ retirement savings to research and vote on matters that are not expected to have an economic impact on the plan.
This proposal is different than the proposed rule on “Financial Factors in Selecting Plan Investments” that the DOL issued in late June and has drawn over 1,000 comment letters – many in opposition. Both this proposal and the one from June are proposed amendments to 29 CFR 2550.404a-1. This week’s proposal states:
Both proposals include a proposed paragraph (g), but the Financial Factors in Selecting Plan Investments proposal proposes an effective date of 60 days after publication of a final rule. Depending on the publication date of the respective final rules, the Department may need to revise paragraph (g) to separately effectuate the final rules.
Reg S-K Modernization: Interplay with Form 10-K “Description of Business”
We’ve been posting a ton of memos about last week’s Reg S-K amendments – including this one from Gibson Dunn that includes perspectives on what the changes mean from a practical perspective and potential problems (as well as a summary table and blackline of the Reg S-K items). In addition, we’ve been fielding quite a few questions about the mechanics of last week’s Reg S-K amendments in our Q&A Forum – like this question about the interplay between the new rules and Item 1 of Form 10-K (#10,433):
The new rule amendments adopted by the SEC last week require disclosure of information material to an understanding of the general development of a company’s business and replace the 5-year (or 3-year for SRCs) time period specified in S-K 101(a) with a materiality standard. How is this rule change intended to apply to Form 10-Ks? There is no discussion in the proposing or the adopting release, but Form 10-K, Item 1. Business is very clear that “the discussion of the development of the registrant’s business need only include developments since the beginning of the fiscal year for which this report is filed.”
Does anyone have views on whether this was an oversight in the new rulemaking? The discussion in both the proposing and adopting releases appears to suggest that the new Item 101(a) amendments apply to all reports/registration statements subject to Item 101(a). But, there was no attempt in the rulemaking to amend the Form 10-K instruction quoted above. Therefore, based on a very plain and clear reading, the Form 10-K discussion is only required to include a discussion of the general development of the business since the beginning of the last fiscal year.
Do others agree / have other thoughts?
John responded:
That’s an interesting observation. I agree that there appears to be a disconnect between the new language of Item 101(a) and the current requirements of Item 1 of Form 10-K. In reading the adopting release, the intent of revised Item 101(a) appears to be that companies must either provide a full blown, principles based description of the development of the business that addresses the matters identified in Item 101(a)(1), to the extent material, or simply provide an update & incorporate the more complete disclosure by reference along with the link required by Item 101(a)(2). But the Form 10-K line item continues to require updating disclosure addressing only the fiscal year covered by the report, so some sort of clarification (or a revision to the 10-K line item) would be helpful.
For a fair number of companies, this issue probably isn’t going to matter very much. That’s because many companies have a practice of continuing to provide a discussion of the general development of their business over the previously required five year period in their 10-K filings, rather than just providing updating disclosure covering the most recent fiscal year. For example, check out GM’s comment letter on the rule proposal in which it objected to the proposal to permit only updating disclosure. GM’s letter noted that “this rule change would have a minimal impact on GM’s current disclosure,” and stated the company’s belief that “the entirety of this disclosure should be included in each filing.”
Last week, the Delaware Court of Chancery rejected a motion to dismiss in Teamsters Local 443 Health Services & Insurance Plan v. Chou – making it the latest in a string of Caremark claims that have made it past the pleadings stage. This blog from Ann Lipton explains the case – and notes that unlike other recent Caremark claims, VC Glasscock appeared to be much more cautious in finding a “failure to monitor.”
What tripped up the defendants in this case was the finding that the board had ignored red flags of illegal activity. The illegal activity involved a subsidiary that was pooling excess “overfill” medication from cancer vials into additional syringes, which led to contamination. This Troutman Pepper memo summarizes the three red flags that the plaintiffs adequately pled the board had ignored:
1. An outside law firm report had previously identified that Specialty, and by extension, Pharmacy, was not integrated into ABC’s compliance and reporting function, which according to the court, constituted a red flag that Specialty’s compliance mechanisms had substantial gaps that the audit committee had failed to follow-up on and rectify.
2. A former executive of Specialty had filed a complaint under seal in federal district court,alleging that Pharmacy’s business was essentially an illegal operation and, although ABC’s 2010 and 2011 Form 10-K disclosed the suit and was signed by ABC’s board of directors, the ABC board failed to take any remedial steps.
3. Specialty had received a subpoena from federal prosecutors which ABC believed, according to plaintiffs, related to the former Specialty executive’s action, which was subsequently disclosed in ABC’s 2012 Form 10-K, which was also signed by the ABC directors, and which was not referenced in the minutes of board or committee meetings.
The court found that it was conceivable that the board didn’t take any action to respond to the compliance report or either of the Form 10-K disclosures – therefore, the litigation is moving forward. This case highlights that directors who sign securities filings not only need to ensure that disclosure of legal proceedings & contingencies is accurate, they need to actually follow up on any concerning substance. As Troutman Pepper’s memo explains, those discussions should also be referenced in minutes:
Corporate fiduciaries and practitioners alike should be aware that corporate fiduciaries will be deemed to have knowledge of disclosures contained in filings and documents that they have executed (such as a Form 10-K). In this regard, it is especially important that directors are aware of, understand, and ask questions about what they are signing as a matter of compliance with their fiduciary duties.
In addition, Teamsters is evidence that minutes of board of directors and audit committee meetings will be heavily scrutinized in litigation. As applied in Teamsters, the absence of references to a red flag in minutes is equivalent to the board of directors or committee never having discussed the matter. Thus, counsel engaged in the representation of boards of directors and audit committees, as well as corporate officers, should be especially vigilant when drafting minutes in connection with the investigation and resolution of red flags.
Minutes should reflect that the risk or red flag was disclosed to the board or audit committee, that the board or audit committee followed-up on that risk and sought additional information, and ultimately, that the board either took at least some action to rectify that risk or red flag or determined that the risk or red flag was not necessary to further address.
NYSE’s “Direct Listings” Rule: Stayed!
Lynn blogged last week about the SEC order granting approval of the NYSE’s “direct listing” proposal for primary offerings. Yesterday, the SEC posted this letter to John Carey, Senior Director of the NYSE, to say that it had received a notice of intention to petition for review of its action under Rule 430 of the Administrative Procedure Act – which, according to this WSJ article, came from CII. Therefore, the direct listings order is stayed until the Commission orders otherwise.
This is just the latest in the ongoing back & forth on this rule change – last year, the SEC rejected the NYSE’s first attempt at a proposal only one week after it was filed.
Transcript: “Distressed M&A – Dealmaking in the New Normal”
We’ve posted the transcript for our recent DealLawyers.com webcast: “Distressed M&A – Dealmaking in the New Normal.”
Corp Fin has sent comment letters to several well-established companies to request more info on their supply-chain finance arrangements – a practice that this WSJ article says the three biggest ratings firms highlighted as a “sleeping risk” last spring. Here’s an excerpt from the June comment letter to the Coca-Cola Company:
We note from your disclosures that accounts payable increased roughly $1.1 billion in 2019 due to the extension of payment terms with your suppliers. We further note from external sources that it appears you have in place a supply chain finance program. To the extent supply chain finance arrangements are reasonably likely to affect your liquidity in the future, please disclose the following:
• The impact the arrangements have on operating cash flows;
• The material and relevant terms of the arrangements;
• The general risks and benefits of the arrangements;
• Any guarantees provided by subsidiaries and/or the parent;
• Any plans to further extend terms to suppliers;
• Any factors that may limit your ability to continue using similar arrangements to further improve operating cash flows; and
• Trends and uncertainties related to the extension of payment terms under the arrangements.
In addition, please consider disclosing and discussing changes in your accounts payable days outstanding to provide investor’s with a metric of how supply chain finance arrangements impact your working capital.
In this response, the company resolved the comment by providing a draft of its intended future disclosure to describe the supply chain finance program in more detail in its MD&A – as well as its impact on cash flows, and associated risks & benefits.
This WSJ article notes that the SEC has increased scrutiny of supply chain finance arrangements over the last year and a half, and names a few more companies who’ve been on the receiving end of that scrutiny. Corp Fin called out supply chain finance arrangements in its Topic 9A Disclosure Guidance in June – and the practice also got a mention in the SEC’s adopting release for last week’s Reg S-K amendments:
Under the proposed amendments to Item 101(c), the revised rule would not explicitly reference the disclosure requirements under Item 101(c)(1)(vi) regarding disclosure of working capital practices, Item 101(c)(1)(ii) requirement regarding disclosure about new segments, or the Item 101(c)(1)(viii) dollar amount of backlog orders believed to be firm. Nevertheless, under the proposed principles-based approach, registrants would have to provide disclosure about these topics, as well as any other topics regarding their business, if they are material to an understanding of the business and not otherwise disclosed.
For example, if supply chain finance arrangements used by a registrant are a significant part of its working capital practices, they may be material to understanding the nature of its commercial relationships. While MD&A disclosures on the topic are more focused on the potential material impact of such arrangements on the registrant’s periodic cash flows and financial condition, the proposed principles-based approach would call for additional disclosure if material to an understanding of those commercial relationships. We discuss the proposals and our revisions with respect to the final amendments below.
CCPA Regs Now Effective: Update Your Privacy Policies
Final regulations under the California Consumer Privacy Act are now effective. There were a few changes from the previously proposed version, according to this BakerHostetler memo. This Quarles & Brady memo highlights several action items that result from the regulations – including an annual review of your privacy policy. Here’s an excerpt:
Review and update your privacy policy to include the more detailed disclosures required by the Regulations. Don’t forget that reviewing and updating your privacy policy must happen on an annual basis. It is not a one and done exercise.
Our September Eminders is Posted!
We have posted the September issue of our complimentary monthly email newsletter. Sign up today to receive it by simply entering your email address!
Last week, Palantir filed the Form S-1 for its anticipated “Spotify-style” IPO. Despite new NYSE rules on “primary” direct listings, the company isn’t selling any shares in this deal – rather, existing shareholders will resell shares of Class A common stock on the NYSE.
For a company that’s been cloaked in mystery and has bestowed the title “legal ninja” on its in-house lawyers, the registration statement – much like a direct listing – is anti-climactic. Which is a compliment to everyone involved! As John tweeted, “the S-1 looks like it was written for grownups.” And unlike some of the other direct listings that we’ve seen, this one does include a D&O lock-up that runs until after the company announces its year-end results.
A few other things that jump out are:
– Prospectus cover page – Underwriter logos are conspicuously absent (like other direct listing companies, Palantir has engaged several financial advisors on the deal – whose names first appear in a risk factor on page 65 – and of course their role is further described in the Plan of Distribution)
– Plan of Distribution – Although there’s no formal book-building, there’s still the impression of some “shadow book-building.” The disclosure is clear that the banks are conducting investors communications & presentations only in connection with “investor education” and not to coordinate price discovery or sales…but it also says that the designated market maker will consult with Morgan Stanley on the opening public price, who will provide input based on pre-listing selling & buying interest that it becomes aware of. I’m sure this section was pored over by legal counsel & banks in excruciating detail, so check out the full thing if you’re interested in how the mechanics are described.
– CEO Letter – Typical stuff we see from unicorns – soaring language about the company and its rejection of a typical business model – but also a critique of Silicon Valley’s “values & commitments” and a pitch that Palantir is forward-thinking, moral and justified in its approach to data collection.
– Privacy – Under the heading “Our Team” on page 168, Palantir describes its “Privacy & Civil Liberties Engineering” team and its “Council of Advisors on Privacy & Civil Liberties” – as well as privacy-enhancing technologies.
– Board Composition & Governance – Three of the six independent directors joined the board in July. The governance structure isn’t in place yet but is contemplated as part of the NYSE listing.
– Multi-Class Cap Structure – In addition to the Class A common shares being resold in the offering, the company describes its Class B common stock (10 votes per share) and Class F common stock (a variable number of votes, all shares held in a voting trust established by co-founders Alex Karp, Stephen Cohen and Peter Thiel, and controlling up to 49.99% of total voting power). A risk factor notes that the company’s cap structure could make it ineligible for inclusion in certain indices.
– Founder Voting Agreements – The company has yet to file the charter with the terms of the “Class F” shares – or the stockholders agreements – and that’s probably the most interesting part of the offering.
This registration statement will likely go effective before the new Reg S-K rules go into effect, so Palantir won’t have to worry about immediately revising its disclosure. While nobody seems too surprised about the net loss figures (this is a unicorn, after all), this Reuters article says that the offering will “test the appetite of capital market investors who have in recent years shown an increasing wariness of backing loss-making startups, most notably WeWork, which botched its IPO last year.” But as we’ve seen, 2020 is a whole new animal.
Shelf Registrations & Takedowns: 10-Page Guide
This 10-page Mayer Brown memo gives a nice overview of the shelf registration & takedown process – including permitted offerings, liability & diligence issues, benefits of the shelf registration process, filing requirements, and a timely section on how market volatility may affect WKSI status and shelf eligibility. The memo gives this checklist of key questions to ask if you’re contemplating a shelf registration or takedown (also see our 140-page “Form S-3 Handbook” for lots of detailed guidance):
1. Is the issuer planning to sell new securities or outstanding securities?
2. Are securities being immediately offered after the registration statement becomes effective?
3. Will the issuer choose to offer securities in a delayed primary offering?
4. Is the issuer considered a well-known seasoned issuer?
5. Is the issuer subject to the baby shelf limitation?
6. Is the issuer considering using a shelf registration for one or more acquisitions?
7. Will the issuer be required to file a post-effective amendment as opposed to a prospectus supplement?
You can still register for our popular conferences – the “Proxy Disclosure Conference” & “17th Annual Executive Compensation Conference” – to be held virtually Monday – Wednesday, September 21st – 23rd. We’ll be covering the latest issues that you need to know – including COVID-related pay adjustments and disclosures, human capital management, navigating proxy advisors, and shareholder proposal rules & trends. Here are the agendas – 15 panels over 3 days.
New this year, we have also added interactive roundtables to discuss pressing topics! We hope you’ll join us for one of these half-hour breakout sessions – you can sign up here. To make the most of your experience, check out this blog for tips for “virtual networking” for lawyers. Here’s an excerpt:
– Be On-Camera: Speaking of cameras, please do not participate in a zoom networking event without being able to have a camera available. That black square with your name will not allow others to see who you are. It would be the equivalent to going to an in-person event and wearing a paper bag over your head. People would like to see who you are. Also, make sure that you are well lit when you are on camera. Too many people are on camera with the light behind them and you cannot see their faces clearly. A light should be in front of you.
– Show up on time (or even early): This is something I advocate for IRL networking, but concerning virtual networking, it is even more important. It is distracting to have someone enter a conversation in the middle of a virtual event, as opposed to a live networking event, and should be avoided at all costs. And, if you have to leave early, you can just make mention that you have an appointment that you have to attend to and thank everyone who was there. You can send a note to the host using the chat feature. Or, you can just leave quietly.
As the blog notes, there are no marketing and business development tactics that cannot be done virtually. So take advantage of this opportunity to meet with your fellow practitioners in a low pressure way, have a good conversation, and make a connection or two.
Earlier this week, McDonald’s filed a Form 8-K to announce that it had filed this complaint in the Delaware Court of Chancery against its former CEO, Steve Easterbrook, who was terminated without cause last year following a board investigation of a consensual relationship with an employee in violation of the company’s Standards of Business Conduct. The complaint seeks to claw back severance payments – and to prevent the exercise of stock options and sale of stock issuable under outstanding equity awards. The collective value of that compensation is estimated at $57.3 million, according to this WSJ article.
The complaint alleges that Mr. Easterbrook acted fraudulently in negotiating his termination, in claiming that he did not have physical relationships with any company employees. In July, McDonald’s received an anonymous employee tip that caused the board to reopen its internal investigation. During the new investigation, the board uncovered photographic evidence of prohibited physical relationships with multiple employees in Easterbrook’s company emails. According to the complaint:
The Company was not aware of these photographs before July 2020, when it discovered them in the course of investigating the allegations regarding Easterbrook and Employee-2. Neither these photographs, nor the e-mails to which they were attached, were present on Easterbrook’s Company-issued phone when it was searched by independent outside counsel in late October 2019 because Easterbrook, with the intention of concealing their existence from the Company, had deleted them from his phone. Unbeknownst to Easterbrook, however, the deletion of the e-mails from the mail application on his Company-issued phone did not also trigger the deletion of those e-mails from his Company e-mail account stored on the Company’s servers.
The Board would not have agreed to the terms of the Separation Agreement had it then been aware of Easterbrook’s physical sexual relationships with three McDonald’s employees, his approval of a discretionary stock grant for Employee-2 while they were in a sexual relationship, and the falsity of his representation to outside counsel that he had never engaged in a physical sexual relationship with a Company employee. That conduct constituted a clear legal basis to terminate Easterbrook for cause.
The complaint references “cause” because Easterbrook’s separation agreement incorporates clawback provisions from the company’s standard severance plan, which require repayment if the plan administrator determines that the recipient committed an act that would constitute “cause” while employed. This case highlights that boards may want the “cause” definition to do more work in this day & age – and why revisiting narrowly-formulated versions on a clear day could afford the board with some additional room to maneuver if it comes to light that an executive has engaged in conduct causing reputational harm. This NYT article observes:
The lawsuit represents an extraordinary departure from the traditional disclose-it-and-move-on decorum that American corporations have often embraced when confronted with allegations of wrongdoing by senior executives. More than a few chief executives in recent years have lost their jobs after allegations of sexual or other misconduct, but for the most part they have departed quietly and the companies haven’t aired the ugly details.
In the #MeToo and Black Lives Matter eras, however, more companies are striving to position themselves as good corporate citizens, responsible not only to shareholders but also to customers, employees and society at large. Mr. Easterbrook’s successor at McDonald’s, Chris Kempczinski, has called for a new corporate emphasis on integrity, inclusion and supporting local communities.
The company launched its lawsuit just before a books & records action that Bloomberg reported was brought against the company by a group of Teamsters pension funds on Wednesday, alleging “a pervasive sexual harassment & gender discrimination problem.” This follows a class action suit filed last fall and other complaints.
The McDonald’s board is taking some heat for relying on Easterbrook’s representation that he had only one affair and not digging deeper in the initial investigation. The anonymous tip came to light last month after McDonald’s held a town hall meeting in which employees were encouraged to come forward with concerns, and the board immediately investigated the complaint. After the board & comp committee chair weathered a “vote no” campaign at this year’s meeting, they now have many months to engage with shareholders and resolve this issue. It’s probably good that the town hall wasn’t in April or May.
On a related note, this CFO.com article reports that the former COO of Pinterest is suing the company for gender discrimination and wrongful termination. Boards are busy right now – and they need to continue to pay attention to #MeToo risks as well as risks arising from the social movement for equity & inclusion. For guidance on navigating potential landmines, visit our checklist on board oversight of sexual harassment policies.
SEC Preparing Proposals to Regulate Chinese Audits
Late last week, the “President’s Working Group on Financial Markets” released a report to address the ongoing issue of the PCAOB being unable to review the work papers for audits of US-listed companies who use Chinese accounting firms – who say, according to this Bloomberg article, that “Chinese law bars them from sharing those documents on the grounds that the documents may contain state secrets.” Because of this stance, China is known as a “Non-Cooperating Jurisdiction.”
The report makes 5 recommendations – but the upshot, as explained in this WSJ article, would be to ban Chinese companies from listing on US exchanges unless they comply with US audit requirements. Here’s more detail from the report:
The PWG recommends enhanced listing standards to require,as a condition to initial and continued exchange listing in the United States, PCAOB access to audit work papers of the principal audit firm for the audit of the listed company.
Companies that are unable to satisfy this standard as a result of governmental restrictions on access to audit work papers and practices in NCJs may satisfy this standard by providing a co-audit from an audit firm with comparable resources and experience where the PCAOB determines it has sufficient access to audit work papers and practices to conduct an appropriate inspection of the co-audit firm.
In addition:
The PWG recommends that,as a specific listing standard, a more specific disclosure requirement or both, requiring enhanced and prominent issuer disclosures of the risks of investing in issuers from NCJs. These actions could include rulemaking and/or issuing interpretive guidance to clarify the disclosure requirements to increase investor awareness, and more general awareness of the risks of investing in such companies.
John blogged a few months ago about a statement from SEC & PCAOB officials on this topic. The Senate has also passed legislation that would amend Sarbanes-Oxley to prohibit the trading of securities – on an exchange or over the counter – for companies that retain an auditor whose reports cannot be inspected completely (and similar legislation has passed the House).
Now, in light of the Administration’s report, SEC Chair Jay Clayton and five other senior SEC officials, including Corp Fin Director Bill Hinman, have issued a statement to say that the SEC will prepare proposals in response to the report’s recommendations. The statement also says that the SEC staff stands ready to assist Congress with technical assistance in connection with any potential legislation regarding these matters.
These tensions don’t appear to be deterring Chinese companies from pursuing US listings – this WSJ article notes that more than 20 companies from China have gone public so far this year on Nasdaq or the NYSE, raising $4 billion in total.
Podcasts: More “Women Governance Gurus” With Courtney Kamlet & Liz
I continue to team up with Courtney Kamlet of Vontier to interview leaders in the corporate governance field about their career paths – and what they see on the horizon. Check out our latest episodes:
– Darla Stuckey, President & CEO, Society for Corporate Governance
This 40-page memo – recently commissioned & released by COSO – explains how companies can use blockchain technology to create more robust internal controls – and also highlights new controls that will be necessary because of the risks that blockchain creates. According to the memo, business use of blockchain will implicate the 5 components of COSO’s 2013 Internal Control Framework as follows:
1. Control Environment: Blockchain may be a tool to help facilitate an effective control environment (e.g., by recording transactions with minimal human intervention). However, many of the principles within this component deal primarily with human behavior, such as management promoting integrity and ethics, which, even with other technologies, blockchain is not able to assess. The greater challenge relates to the intertwining of an entity with other entities or persons participating in a blockchain and how to manage the control environment as a result.
2. Risk Assessment: Blockchain creates new risks and simultaneously helps to mitigate extant risks, by promoting accountability, maintaining record integrity, and providing an irrefutable record (i.e., a person ororganization cannot deny or contest their role in authorizing/sending a message or record).
3. Control Activities: Blockchain can act as a tool to help facilitate control activities. Blockchain and smart contracts can be a powerful means of effectively and efficiently conducting global business (e.g., by minimizing human error and opportunities for fraud). The collaborative aspects of blockchain, however, can introduce additional complexity, particularly when the technology is decentralized and there is no single party accountable for the systems that fall under ICFR.
4. Information & Communication: The inherent attributes of blockchain promote enhanced visibility of transactions and availability of data, and can create new avenues for management to communicate financial information to key stakeholders faster and more effectively. One aspect, in particular, for management to consider in applying blockchain is the availability of information to support the financial books and records, and related auditability of information transacted on a blockchain.
5. Monitoring Activities: The promise of blockchain to facilitate monitoring more often, on more topics, in more detail, may change practice considerably. The use of smart contracts and standardized business rules, in conjunction with Internet of Things (IoT) devices, may alter how monitoring is performed.
Audit Adjustment Waivers: Red Flag for Restatements & Audit Costs
Using a sample of 3,144 audits, this recent study found that the decision to waive auditor-proposed adjustments to financials may have unforeseen consequences of increased restatement risks, incentives to manage earnings, and higher audit costs. Here’s an excerpt:
We estimate that at least 80% of pre-audited financial reports contain misstatements detected by auditors, and management frequently does not make the proposed adjustments. Perhaps surprisingly, management corrects all misstatements only about 12% of the time and waives all proposed adjustments about 50% of the time.
We find that waived adjustments are linked both to lower financial reporting quality measured by material misstatements and to incentives to meet/beat analyst forecasts; the latter finding suggests disposition decisions can be an earnings-management mechanism.
We find that auditors respond to the increased restatement risk associated with management’s decisions to waive audit adjustments by increasing audit effort this period and are able to pass along at least some of these costs to their clients. The auditor’s response is persistent: auditors are likely to propose more next-year audit adjustments when clients waive adjustments in the current year, leading to increased effort (audit hours) and costs (audit fees) next year. Finally, we identify one reason managers may waive adjustments – to meet or beat analyst consensus forecast estimates.
The professors conclude that many of these waivers result from focusing on quantitative thresholds – and overlooking qualitative facts that impact the materiality of missatements.
Call for Photos: Marty Dunn Tribute
Our “Proxy Disclosure & Executive Pay Conferences” are coming up next month – and while I’m very excited about our agendas & speakers, the conference won’t be the same without Marty Dunn on the roster. We’ll be running a tribute to Marty and would appreciate any photos from the community that could help make it special. Please email me with anything you’d like to share – liz@thecorporatecounsel.net.
Some felt the statement pushed the theory of “shareholder primacy” aside – and we’ve been going around & around since then on whether this was simply a return to the BRT’s original position, whether it affects directors’ fiduciary duties, whether investors care, and whether corporate practices align with the statement. Many have steadfastly emphasized that this is just a debate on semantics and that the BRT statement didn’t change anything about how management or boards actually function, since the promotion of other stakeholders can typically be justified as something that also benefits shareholders in the long run.
Consistent with that view, this forthcoming article from Harvard Law Profs Lucian Bebchuk and Roberto Tallarita, which was also the subject of a WSJ op-ed last week, found that very few signatories involved their boards in the decision to sign the statement. Here’s an excerpt:
To probe what corporate leaders have in mind, we sought to examine whether they treated joining the Business Roundtable statement as an important corporate decision. Major decisions are typically made by boards of directors. If the commitment expressed in the statement was supposed to produce major changes in how companies treat stakeholders, the boards of the companies should have been expected to approve or at least ratify it.
We contacted the companies whose CEOs signed the Business Roundtable statement and asked who was the highest-level decision maker to approve the decision. Of the 48 companies that responded, only one said the decision was approved by the board of directors. The other 47 indicated that the decision to sign the statement, supposedly adopting a major change in corporate purpose, was not approved by the board of directors.
Bebchuck & Tallarita also looked at the corporate governance guidelines of the companies whose CEOs signed the BRT statement – and found that most of them reflect a “shareholder primacy” approach – e.g., stating that the business judgment of the board must be exercised in the long-term interest of shareholders.
I haven’t been in any of these c-suites or boardrooms, but I’d venture a guess that many had already been discussing long-termism and stakeholder governance prior to the BRT’s statement (even if they weren’t using those specific catchphrases) – with a view towards maximizing long-term shareholder value. Were the BRT commitments illusory, or just within the scope of those prior discussions? Either way, the absence of board involvement seems to indicate that no change to director fiduciary duties was intended.
This article from UCLA Law Prof Stephen Bainbridge agrees that the evidence is that most BRT members remain committed to shareholder value maximization – and suggests two possible reasons why the BRT publicly shifted its position:
First, the members may be engaged in puffery intended to attract certain stakeholders for the long-term benefit of the shareholders. Specifically, they may be looking to lower the company’s cost of labor by responding to perceived shifts in labor, lower the cost of capital by attracting certain investors, and increase sales by responding to perceived shifts in consumer market sentiment. They may also be trying to fend off regulation by progressive politicians. Second, some BRT members may crave a return to the days of imperial CEOS.
Corporate Purpose: Take 2 for the “Takeover Titans”?
Last month, I blogged about some back & forth between Skadden and Wachtell on the ongoing “corporate purpose” debate. One member pointed out that this is a revival of the old 1980s Skadden v. Wachtel debates when Joe Flom (now deceased) and Marty Lipton (clearly alive) made themselves famous in the hot times of corporate raiding by touring with show about their rival forms of takeovers and defenses.
Here’s an old University of Michigan newsletter that recounts a panel discussion including these two giants. And here’s a recent interview of Marty Lipton in “Business Law Today,” in which he comments that those touring days might have been the point when he knew he was a leader in the field:
JP: Was getting attacked by the folks from the Chicago School the time that you felt like, “OK—I’ve made it on the national stage”? When did you realize that you’re a leader in this field?
ML: I don’t know whether that’s possible to answer. I would say mid-’80s with the poison pill more than anything else. I certainly wasn’t an intellectual leader. From 1976, when Steve Brill wrote an article (“Two Tough Lawyers in the Tender-Offer Game,” NY Mag., 1976) about Flom and myself being the two lawyers on opposite sides in tender offers, I was a known quantity, and people were calling who didn’t know me but just from reputation were seeking representation in takeover situations. So it’s hard to say.
Tomorrow’s Webcast: “CEO Succession Planning in the Crisis Era”
Tune in tomorrow for our webcast – “CEO Succession Planning in the Crisis Era” – to hear Kerry Burke of Covington, Rusty O’Kelley of Russell Reynolds and Amy Seidel of Faegre Drinker discuss the CEO succession planning alternatives that are available to boards, analyze how to maintain a succession plan that’s adaptable to a dynamic business environment and highlight legal, contractual and disclosure minefields to avoid.
